John ZechnerA Comment -- General Comments From an ExpertA CommentaryCOMMENTAug 04, 2022

He didn't expect any. It's relatively de minimis from the perspective of what it really means broadly for Canada. 

Most of it is still noise and bluster with Trump's belligerent style and how he deals with everybody, always. He takes it to an extreme, as far as it will go, and then he starts to bring it back. Question is, when does he start to bring it back? And do we want to bring it back? That's the unknown.

From a political standpoint, if you understand the importance of the US elections and Congress staying with the Republicans (increasingly seeming as though it won't), what can Trump do on the trade file to help with that? In line with that, he probably wants a deal of some sort before the elections.

If you're partisan, you already know which way you're going to vote. The moderate person makes up their mind in the last few weeks. And often, it depends on how they're feeling about things on the day they vote. That will determine where the swing vote will go.

He expects the back and forth to continue even into October.

It's everything. But today, it's magnified on chips. Tomorrow, it'll be something else. Three days from now, it could be back to the Middle East.

All those things are relevant. The thing that matters a lot, in the big picture, is earnings. Right now, earnings are still good and growing. Analysts keep revising estimates upwards. As long as that happens, corrections in equities will be small until the market says "Hmmm, maybe it isn't sustainable."

The US administration is trying to do something about interest rates and minimizing the cost of funding all this debt that will be endless for decades.

US labour market was looking better. Now, with a couple of revisions, all that is showing softness. How strong is the US economy when you neutralize earnings? That is, if you take the AI capex spend out? It's still pretty good, but there are a lot of knock-on effects in other industries from all that spending that otherwise wouldn't be there.

Outside of that, he's not sure that the economy today is really strong. Shrinking labour force because of the aging demographic. There's competition from AI, and a skills mismatch in terms of what society needs.

Holding US treasuries pays you a yield, while holding commodities pays you nothing. So there's an element of income when you're talking about foreign reserves or monetary reserves such as gold/silver bars.

Not sure you'd want to hold uranium. For other critical minerals, there's the cost of storage, decay, theft, and other issues. Not practical for a central bank to store things like that. That said, there are critical storage things like strategic petroleum reserves. So there could be an element of a strategic reserve in terms of critical minerals and metals to help with supply constraints from time to time. He'd be OK with something like that.

Central banks understand gold's role in the monetary system. Decades ago, debt to GDP wasn't meaningful; today everywhere around the world, it's tragic. And only going to get worse. Central banks will probably continue to buy gold as a backing to reserves.

If it was just one government doing with massive debt, then you could isolate them and see the currency get obliterated. Think Argentina or Turkiye. 

The US is the reserve currency of the world, so it has this luxury that not everyone has when it comes to fiscal prudence. Japan's debt to GDP, for example, is double what it is in the US. The US debt situation can go on for decades. The question is at what cost to finance, to future growth, to political capital?

Those issues are above his pay grade, but he has some thoughts in today's Educational Segment.

US Government Debt of $40T
Jackson Hole is this week. The market didn't like Warsh's laissez-faire approach to interest rates at the last FOMC meeting. Bonds have been selling off, but not just in the US. It's a story of total debt to growth that probably ends badly.

Larry brought along a chart that shows revenues/expenses of the government as a percentage of GDP. Post WW2, for many decades, revenues and expenses were pretty aligned. Overall debt to GDP came down after financing WW2. Then partisan politics started kicking in over in Washington, DC, with parties wanting to outdo each other. So deficits and debts got crazy.

Today, the amount of debt to GDP is 121%. Debt is $40T, on a $32T economy. Question is:  How do we finance all of this?

One of the mandates of the US government is to lower the cost of debt. As long yields got higher, Scott Bessent said a few weeks ago that they were going to buy back some of their long bonds, issue a few more treasury bills, and twist how they raise $$ for the government. There's a hope and expectation that stablecoins will be backed by US treasury bills.

His next chart shows the total cost of US treasury bills, bonds, and the current yield. Of all treasuries outstanding right now, current yield to maturity is 4.55%. The old ones are in the range of 3.6%. So new debt is coming in around 90 bps more than the debt that's maturing. That'll just put upward cost on the debt, and add hundreds of billions to the deficit.

Catastrophic in terms of what it means for future spending and budgets. It limits governments' ability to help when things get bad. Times have been good, and the government's still spending massively. We've been fiscally managed by the lot of them around the world -- Republicans, Democrats, Liberals, Conservatives. 

There's a universal hate on right now for long bonds. There's a trade here, but not for the faint of heart (as yields could keep rising). Speculators are bearish on long bonds. Hasn't been like this since the last time yields were over 5%. Price of these bonds is really low. You can use some options to protect yourself. On risk/reward, long treasuries are one of his favourite asset classes right now. See his YouTube channel.

For the most part, earnings have been roughly in line or slightly ahead. That's been reflected in the markets. The bigger impact on the quarter is the decline in inflation. That's a positive, we'll see if it continues.

Those two things have set a good tone for the quarter.

The challenge with the rhetoric coming out of the White House is that the market's just ignoring it. It's just constant, and it's disconnected from reality. If we're going to have a peace deal, let's have one. Striking around the Gulf is just causing everyone to suffer.

He doesn't see the Iranians giving in anytime soon.

You need to think about 2 segments of the consumer, the classic K-shaped economy. Metrics reported by Visa recently showed sustained double-digit returns and growth. That speaks to a healthy consumer. Median rents in NYC are $5k a month. Though that might be a bit excessive, it points to consumers who are, generally, optimistic.

There's a lot of spending going on in the US with AI and data centres, and that's permeating through the economy. So the US consumer who has a job or is exposed to markets is doing quite well. Those who do not have tended to suffer, and we're starting to see that in the labour markets.

WMT would be exposed to the less economically advantaged consumer (though the wealthy do spend there). WMT results are a bit disconnected from the portion of the population that actually drives the US economy.

Be wary of any stock that benefits from ETF fund flows because when the market decides it doesn't like the stock anymore, everyone just sells en masse.

With the dot-com era, and the promise of what it was for e-commerce, it was very hyped in 2000. But the crossing of the chasm didn't happen until 2020, when everyone was locked in the house and had to buy online. 

If you look at what the promise of AI is, the likelihood of what's being promised now to be delivered now is virtually zero. We have to put some roadblocks around our assumptions. That's the fundamental reality.

From an investor reality, the trend is your friend. You should have some exposure to AI. Be careful how you risk-manage it. If you're playing with the house's money, then trim, take some off the table, and put it in defensive names. If you're a growth investor and 100% invested in AI, that trade will work. Until it doesn't. And you'll be down 50%.

For commodities, his firm tends to favour large companies. This gives you the dividend, share buybacks, and a bit more fiscal discipline. The oil patch has rediscovered its discipline. Wait and see how long that lasts when money starts flowing again -- we might see a lot of drilling or acquisitions that make no sense.

Sees small companies as trading vehicles at the margins, while holding big companies as core positions.

Last 2 years for Canadian financials have seen outsized performance, though that trend has largely been in line with US and Europe. From a macro view, Canada is not actually that healthy -- trade war with our biggest partner, soft labour markets. 

If you're not going to have a capital gains tax problem, trimming here would make some sense. No need to own more than one bank, more than that adds to your systemic risk. A balance sheet recession will affect them all. In 2008, for example, they all sold down.

Messaging from Scott Bessent yesterday is that they're buying back money because the US economy has a major fiscal challenge. This tells us that we have some trouble ahead. You're probably misreading the tea leaves if you don't take some money out of your growth names and pivot to some defense.